Not for the first time, and certainly not for the last time, the words “Brexit” and “Trump” have dominated financial media headlines.
After months of prevarication and procrastination, UK PM May finally laid out her government’s plans as to what form of Brexit they are seeking. The commitment to leave the single market (and, de facto, the EU customs union[1]) means that it will be of the “harder” variety. But the stated intention to deliver a “smooth and orderly” exit, ie. no cliff, combined with the largely pro-EU British parliament getting a vote on the final deal certainly helped soften the edges[2].
Meanwhile, President Trump continued to muddy the international waters by threatening German carmakers that he would seek to impose a 35% tariff on imports to the US made by their Mexican subsidiaries; a statement that earned a pithy replay from the German Vice Chancellor, namely that if Trump wished to see more American cars on 5th Avenue they should “make better cars”[3].
These latest developments are an important and timely reminder that even though investors have had several weeks/months to digest what were for many[4] the two big political upsets of 2016, divining the medium-term macroeconomic and financial market implications, both domestically and internationally, remains extremely challenging given the ongoing and considerable uncertainties.
Despite all of his talk – not to mention numerous tweets – Trump is still very much an unknown quantity given his lack of experience in political office. Similarly, PM May has laid out her stall as to what she is seeking in the Brexit negotiations (her speech contained 12 key guiding principles[5]) but the eventual form of Brexit is not set unilaterally. It is a negotiated outcome, hence the end result is still unclear[6].
As can be seen in the exhibit below, the deep pessimism towards UK economic growth observed immediately following the June 23rd referendum vote has now abated, albeit at a more measured pace than was witnessed in late summer. Similarly, and very much in mirror image, economic uncertainty has also declined, indicating that the prevailing view of the crowd is that the “hit” to the UK economy from Brexit will be not terribly significant.
Exhibit 1. Crowd-sourced Economic Growth & GBP Sentiment – UK
Source: www.amareos.com
This relatively benign assessment may, in the end, prove to be overly optimistic. Nevertheless, it is important to recognize the current neutrality of the crowd when it comes to thinking about the near-term trajectory for the UK economy and GBP because although the eventual destination may still be opaque, the journey – any journey – is just as much determined by the starting point as the end point[7].
Specifically on the currency, the recent four-big figure rally in GBP/USD after the retest of last October’s “flash crash” lows has got some investors pondering whether the depreciating trend still has legs[8].
If, as was the situation back in late July / early August, sentiment towards the UK currency was extremely negative we would have more sympathy with this view. But, as just shown, this is patently not the case at present[9]. Hence, we remain bearish on the medium-term outlook for GBP and view any near-term rebound as simply an opportunity to get better entry levels.
Certainly, the macroeconomic rationale for GBP to continue to weaken remains sound. A currency’s trajectory is not simply a barometer of an economy’s health as some commentators would have us believe. Rather it should be more correctly viewed as an important additional, externally-focused, release valve[10].
For an economy as externally unbalanced as the UK – the current account exceeded more than 5% of nominal GDP in 2015 (a post war wide) – currency depreciation is a growth-supportive imperative because it reduces the onus on domestic demand contraction to drive the rebalancing process[11].
That is, of course, as long currency weakness does not lead to a sustained rise in inflation, something that would, by jeopardising BoE compliance with their policy mandate (a crucial consideration for a central bank that values its operational independence) likely prompt a monetary tightening from the occupants of Threadneedle Street.
So far, the BoE has been rather relaxed about an inflation overshoot as evidenced by the fact that the UK monetary policy stance has been unalterably accommodative despite the BoE’s last Inflation Report (November 2016) showing inflation forecasts consistently exceeding the 2% goal over the two-year-ahead projection horizon[12].
This should not, though, be viewed as complacency on their part. Indeed, in his latest speech BoE Governor Carney[13] presented a thorough examination of a central bank’s loss function, explicitly considering the trade-off between compliance with the target and likely negative impact upon the economy; clear evidence they are well aware of such perceptions.
That said, with the December inflation numbers coming in above expectations (the y/y rate rose to 1.6%, a two-year high), market chatter that the BoE could be forced into reconsidering its accommodative policy stance could strengthen, providing a temporary fillip for the currency.
The good news for the BoE, the UK economy, but not the currency, is that crowd-sourced UK inflation sentiment, which surged after the Brexit result, has fallen back markedly over recent weeks. This strongly suggests that even if near-term UK inflation outturns are stronger than anticipated, it is still largely a transitory shock (see exhibit below)[14] [15]; one that should not warrant a response from the BoE.
Exhibit 2. Crowd-sourced Future Inflation Sentiment – UK
Source: www.amareos.com
Referring back to May’s Brexit speech, one of the more interesting aspects was her attempt to pivot the post-Brexit narrative away from one of international disengagement to one of profound internationalism. To wit,
“June the 23rd was not the moment Britain chose to step back from the world. It was the moment we chose to build a truly Global Britain.”
We can’t be the only ones who saw the uncomfortable juxtaposition between May’s “unleashed from the legislative bonds of EU bureaucracy we can embrace new overseas markets” viewpoint and the escalating protectionist rhetoric from President Trump mentioned at the outset. Sure, Trump has said that he wants a fair and swift trade deal with the UK – a marked changed of tone from his predecessor – but if trade tensions are escalating globally it is difficult to see how Britain will achieve such lofty internationalist ambitions.
In our opinion, Trump’s rhetoric is largely just that, rhetoric; part of his famed hard-ball negotiating tactics. However, even if this interpretation is correct, and his statements are political posturing, we can’t help but have misgivings.
The Davos speech by Chinese President Xi – the first time a Chinese official of such seniority has attended the WEF – not only allowed the Chinese to positon themselves on the moral (economic) high ground by extolling the merits of globalization, but also implicitly highlighted their profound sensitivity to this subject. In such situations misinterpretations can very easily lead to unintended but nevertheless unfortunate outcomes.
As we have noted in previous Market Insights[16] (and tweets[17]) in the weeks following Trump’s unexpected victory the crowd displayed some very definite views as to how the US economic outlook would evolve: in a word “reflation”. Buoyed by anticipated fiscal stimulus of the most multiplier friendly kind (ie. infrastructure), previous negativity towards US economic growth evaporated and inflation sentiment took off.
However, just as in the UK, the reflation balloon has developed an increasingly audible hiss of escaping air. Such a reversal in the US inflation outlook sentiment indicator (see exhibit below) is consistent with the crowd beginning to shift their focus away from Trump’s reflationary domestic economic agenda to the potentially less positive international ramifications of his policies.
Exhibit 3. Crowd-sourced Future Inflation Sentiment – US
Source: www.amareos.com
Furthermore, this is not the only marker we have found in the crowd-sourced sentiment data we track that could be signalling more cautious crowd attitudes towards a Trump presidency. One obvious corporate casualty from any significant US-China trade spat would be Apple, a company deeply reliant on a fully functioning global supply chain given the bulk of its production, especially the iconic iPhone (a key revenue source), comes from China.
As shown in the final exhibit, while it may not be readily apparent from market prices – a rising tide floats all boats – one notable corporate absentee from improved crowd sentiment following Trump’s victory is the US tech giant. In early November, crowd-sourced sentiment and optimism towards Apple peaked, and has been falling ever since, indicative of increasing pessimism.
Exhibit 4. Crowd-sourced Sentiment – Apple
Source: www.amareos.com
Maybe this reversal in sentiment towards Apple is due to idiosyncratic corporate factors, but then again, maybe it isn’t!
[1] A customs union implies that the UK cannot enter into bilateral trade deals (more later).
[2] The strict classification of Brexit as either “hard” or “soft” is largely meaningless. Politics is the art of compromise meaning that it is better to think in shades of grey (hence the title).
[3] Having never driven one (make of that what you will) who are we to comment.
[4] Obviously we do not include Amareos clients in this list for reasons outlined here: https://amareos.com/blog/whisky-tango-foxtrot/.
[5] See: https://www.gov.uk/government/speeches/the-governments-negotiating-objectives-for-exiting-the-eu-pm-speech.
[6] See footnote 2 above. Why this point does not seem to be understood by those – largely Remainers – who continually demand to know what the final Brexit deal will be simply defies logic.
[7] This is the basis for the punchline for the infamous Irish joke about “not starting from here”.
[8] One UK portfolio manager described GBP as difficult to trade because the currency is “heavily influenced by sentiment and headlines”, something we at Amareos naturally see as an opportunity.
[9] See: https://amareos.com/blog/outsmarting-the-crowd/
[10] Or an additional degree of policy freedom in economist speak. NB: Obviously this assumes that the currency is operating unfettered i.e. there is no official targeting or intervention.
[11] For an example of the negative impact of a solely demand-driven rebalancing of a current account deficit consider the Greek economy a few years back.
[12] In fact, the central tendency shown in the fan charts shows inflation could even exceed the one percentage point band either side of the 2% central rate that serves as a trigger for the governor to write to the Chancellor explaining the reason for the overshoot and to outline, if any, remedial action is to be taken.
[13] http://www.bankofengland.co.uk/publications/Documents/speeches/2017/speech954.pdf
[14] The crowd-sourced sentiment data only has a 10 year history – a period of relatively benign UK inflation trends. Hence, even though sentiment appears extremely high, it is probably fair to assume that it is consistent with only a moderate overshoot of inflation relative to the target.
[15] As we stated in a previous Market Insight the past several years have shown us that inflation is not just a monetary, but also psychological phenomenon – see: https://amareos.com/blog/caveat-venditor/.
[16] See: https://amareos.com/blog/goodbye-2016-welcome-2017/
[17] For a daily sentiment-tinged financial amuse bouche follow us @Amareos_info.
